January 5, 2009

The Dodgy Thinking Behind the State Budget Bailout

By George Lightbourn

The drama about to be played out in the Wisconsin budget is a small subplot of a larger drama being played out across the country. The story line in this drama is that state government is a blameless victim, caught in a nasty economic cycle. But is that the case?

As contemporary Americans, we have become far too comfortable living beyond our means. It will take time to adjust to our new reality, one defined by limitation and sacrifice.

Of course we should have paid attention to those who were telling us that our prosperity was illegitimate, a mirage. From top to bottom, our economy had an insatiable appetite for spending. Only now are we facing the reality of just how far beyond our means we have been living. We bought more house than we could afford, our car of choice was an SUV when we should have been driving a nice sedan and Silicon Valley has had to work overtime to keep up with our demand for smaller, speedier and trendier technology.

All of this consumption was fueled by the promise of a shinier future. So we borrowed and borrowed and borrowed. We borrowed so much - $14 trillion – that our household debt nearly equals the annual output of the entire U.S. economy.

Did government avoid this tsunami of overspending? Of course not, it bellied up to the trough and blithely went about spending money it simply did not have. We all know about the skyrocketing federal debt, but state governments have found ways around their balanced budget requirements. For example, Wisconsin state accountants recently closed the books on the last fiscal year showing a deficit of $2.5 billion. That was the deficit as of July 31, before the current recession hit full stride.

When we see state government carrying a deficit of that size from year to year, it should set off warning lights. State government spending is unsustainable even in good times. It is logical then to use this time of fiscal stress to confront the unsustainable level of state spending, to reassess, to change, to shrink. It would be good for everyone to have government spending reduced to a sustainable level. But that is probably not in the cards.

Paul Krugman, the columnist for the New York Times who was recently awarded the Nobel Prize for economics, articulates the philosophy that will drive the thinking as to how Wisconsin will address its budget crisis. “It’s true that the economy is shrinking. But that’s the result of a slump in private spending. It makes no sense to add to the problem by cutting public spending too,” wrote Krugman. Krugman’s line of thought is not only wrong; it stands to make Wisconsin’s long-term prospects much worse.

Governor Doyle, apparently a devotee of the Krugman school of thought, last week joined three other Democratic governors in calling for no less than $1 trillion of federal largess to be showered on state governments. More than half of the $1 trillion would be used to prop up existing spending, much of which would be focused on education. There can be no doubt that a substantial federal bailout will be needed if Governor Doyle has any hope of funding 2/3 of schools while also following through on his promise to eliminate the QEO.

What Krugman, Doyle and the other governors aren’t talking much about is the long term. If the federal government $1 trillion further into debt to prop up state government spending, what will happen next year and the year after that? Is any of this sustainable; the state government spending or the federal debt? We all know the answer.

We cannot afford to be distracted by the prospect of added federal funding. If it comes, fine, however we need our Governor and our Legislature to deliver a state spending plan that works in both good times and bad. To meet that test they must reduce state government spending substantially, to a level that is supportable through the ups and downs of the economic cycle.